Openness, External Risk, and Volatility: Implications for the Compensation Hypothesis

A central assumption in the globalization literature is that economic openness generates economic insecurity and volatility. Based on this assumption, scholars of international political economy have proposed the compensation hypothesis, which claims that globalization bolsters rather than undermines the welfare state by increasing public demand for social protection against externally generated economic instability. The openness-volatility link is dubious, however, on both theoretical and empirical grounds. In this study, I revisit the volatility assumption, focusing on a crucial difference between openness and external risk in their effect on volatility. My statistical analysis of a panel data set from 175 countries (1950–2002) finds a consistent effect of external risk on volatility of the major economic aggregates, but a largely insignificant effect of openness. These findings suggest that economic volatility may be a mistaken link in explaining the openness-spending nexus, calling for further research on the causal mechanisms linking the two.Earlier versions of this paper were presented at the 2002 Annual Meeting of the American Political Science Association, Boston, and at the 2004 Ph.D. Colloquium of the Interdisciplinary Studies Program, Florida Atlantic University. My deepest thanks go to the late Michael Wallerstein whose insights, guidance, and encouragement were indispensable for this research. I also thank Stephen Haggard, Dukhong Kim, Jeffrey Morton, Edward Schwerin, Yumin Sheng, and Yael Wolinsky-Nahmias for their invaluable support and thoughtful comments. Finally, I would like to appreciate the editor-in-chief and two anonymous reviewers for their perceptive criticisms that greatly improved this article.